I attended NYC Technology Startups’ Everything You Wanted To Know About Startup Law at Pivotal Labs on November 19, 2012 to see Roman Fichman, a startup-friendly attorney specializing in startups, internet law, intellectual property and technology, and Boris Segalis, partner of InfoLawGroup, specializing in social media, e-commerce, data confidentiality, privacy and security.
Boris Segalis talked about the importance of understanding privacy-related matter within the technology startup field. “Many companies don’t think about security and governance,” Segalis said. “And when they don’t, they pay for it dearly down the road.” Segalis said that companies that don’t build legal structures in the beginning of the startup’s life end up with depressed purchase prices. “Information governance is a small but important niche area,” he said.
InfoLawGroup is a national boutique firm with a focus on information law. The firm focuses on privacy, technology, media, advertising and information management. Their client industry sectors include: Social Media, E-Commerce, Entertainment, NRG, Payments, and Finance.
To Segalis, regarding information governance, knowledge is power. “Information is critical for business success,” he said. Any information — know-how/trade secret, business methods, Twitter feed, Customer Relationship Management Database, tracking data, payments, cross-border transfers, and traditional — are all subject to privacy law. Big companies in advertising require vendors to be part of the NAI (Network Advertising Initiative), a self-regulatory organization for the vendors to be able to sell data for legitimacy reasons. “For companies dealing with information adhering to the law, learning about it is extremely important, else face the consequences,” Segalis warned.
Personal information identifies an individual. It enables a party to contact an individual and identifies a device connected to the internet. Personal information is defined by laws (state, Federal, international level), self-regulatory schemes (MMA, NAI, PCI, DOC Safe Harbor), and the FTC.
Privacy is the appropriate use of information as defined by law and customer expectations. “Privacy is not a bad word,” Segalis said. “It demands fairness and transparency.” He went on to say that security is the protection of information. Confidentiality (protection against unauthorized access to data) and data integrity are two aspects of protecting data.
Protecting personal information matters because it broadens and protects the playing field in regards to the business model. It also builds trust between business customers (including foreign customers), builds publicity, customer confidence, adheres to compliance, and attracts investors and buyers. Protecting PI can be followed by the requirements set by the Federal and state governments. It provides guidance for privacy principles. If the measures are not followed, they are enforced by the FTC and by “the Institute of Public Shaming,” which is a concept of public advocates revealing shortcomings by large corporations.
Roman Fichman presented “5 1/2 Legal Mistakes Startups Make” and started with Incorporations as the first major mistake. “Startups fret too much about incorporating,” he said. “There is no straight answer, though,” he admitted. “They are all custom tailed to your startup.” There are four major categories to consider when incorporating: liability, taxes, business needs or equity.
“There are a lot of formations to consider when incorporating,” Fichman said. There are LLCs, “Which are not corporations and not partnerships either, but a mixture of the two,” and there are LLPs, “Which are limited liability partnerships, where investors can’t invest without becoming partners, S-Corps, “Which are great for family businesses, where investors become equal to the founders, and there are no preferred stock,” and C-Corps, “Which are general corporations.” According to Fichman, LLCs do not generate profit in the beginning, “but that is great for you,” he said. “The losses mean less taxes. There are also no statutory regulatory laws that govern certain parts of LLCs, which are both good and bad.” C-Corps, on the other hand, share structure. It can be public or private and there is a board, shareholders, executives, and of course, double taxation, which mean, “C-Corps are taxed on profits, which are then distributed to shareholders, then the distributed money are taxed once again.”
Regarding incorporating in New York or Delaware, Fichman sided with Delaware as it has a “pre-developed body of law and laws that benefit shareholders. New York requires that 10 of the largest shareholders be personally responsible for employees’ salaries.
On equity, “which is the idea that you own something,” startups focus on “percentages, not the number of shares, which is troubling,” Fichman said. “This is detrimental to the stakes,” he said. Taking percentages instead of concrete numbers presents a problem because it is not clear — “Is it 2% of 50% of shares or 100% of shares?” he asked. “Numbers give a clear and uncontestable idea of what the investor is receiving — as well as founders.” There are three ways to distribute stock. 1) Founder stock (or lost stock) is “mythical founder stock. It is a nominal value, an intrinsic value that a company has.” 2) Option Pool, “which is tricky to manage. You want to have enough equity available for shareholders and investors, but not too much. Investors want first dibs on the option pool and dilute the pool, so be careful.” 3) Stock Options — “If you’re a full-time employee, you will benefit from this. If you’re an advisor, go with restricted stock. That would, however, require extensive documentation.”
Next, Fichman discussed intellectual property. “There are three types of IP that you will come across,” he said. “IP you develop, IP someone else has developed and IP you use.” He suggested that if you are using an IP that you have developed, try to patent it as quickly as possible, but “it is on the expensive side, about $10,000 to $15,000.” For IP that someone else has developed, Fichman warned that “the developer of the IP owns the code or the product, unless you and the developer has signed an agreement saying that the IP is under your name.” And for IP that you use, “make sure you get a license for it or make sure it is open-source. If not, you will face lawsuits.”
Startups also struggle with lacking documentation or having too much documentation, which is the case with working with lawyers not versed with laws regarding startups. “When you get investors,” Fichman said, “you have to change your entire deck anyway, so having too much documentation uses up valuable capital.” Fichman also recommended that startups have at least “some sort of memorandum regarding the people that you are working with. Look at partnership agreements.” He added that grant of stock options and restricted stock should be consulted with a lawyer.
On employees, Fichman said startups need to abide with New York laws. Pay should be at least minimum wage. Startups have a chance of getting audited three to six months, but that chance is not that high. “Interns don’t exist unless they are getting school credit. If they are at your office for more than 20 hours a week, then they are considered employees and need to be paid at least minimum wage. If not, the startup will get audited or fined. Interns can also come back and sue startups for back wages.”
On advisors and service providers, Fichman said, “It’s up to you to find those attorneys to help you find the one you like or are relevant to your needs.”